Update on directors' duties in insolvency

It’s no surprise that company directors worry about their duties, responsibilities and possible liabilities if their business is facing financial difficulties. They are right to do so because directors’ duties change where a company is or is likely to become insolvent. For most company directors, insolvency is uncharted territory.

In order to assist company directors in this situation, a new Information Note (pdf) has been issued by the Corporate Enforcement Authority (CEA) that sets out how they view the newly codified fiduciary duty of directors in circumstances where a company is about to become or has become insolvent. The guidance is in response to the introduction of the European Union (Preventative Restructuring Regulations) 2022 (“the Regulations”) which are concerned with companies which are facing financial difficulties.

This article summarises the requirements and approach that directors are expected to follow when they find themselves overseeing a company which has become insolvent and outlines the basic tests as laid out in company law that are generally used to establish whether a company is considered to be insolvent. Directors must understand these matters to avoid unknowingly breaking the law and risk directorial misconduct sanctions.

A primary duty of company directors is to know the financial position of their company at all times. Therefore there is a basic requirement to maintain adequate books and records. These books and records will then allow the directors assess at any point in time if the company is insolvent and adopt appropriate courses of actions if this is found to be the case. At such a point in time directors have then a duty to put creditors’ interests first. The directors must carefully consider if it is appropriate to continue trading or cease trading and be able to justify their decision making which could be later challenged if the company has a liquidator appointed. The directors can take a short period of time to consider alternative strategies and usually do so by engaging the services of an insolvency practitioner who might advise on a range of alternatives from restructuring options to save some or all of the business or the immediate winding up of the company through a liquidation.

The key aspects addressed in the CEA Information Note which expands on the above are set out as follows.

Importance of maintaining adequate accounting records
There is a statutory obligation on every company to keep (or cause to be kept) adequate accounting records. Ensuring that a company complies with this obligation is the legal responsibility of the company’s directors.

For the above purpose, adequate accounting records are those that:

• correctly record and explain the transactions of the company,
• enable, at any time, the assets, liabilities, financial position and profit or loss of the company to be determined with reasonable accuracy,
• enable the directors to ensure that any financial statements of the company are prepared in accordance with the relevant legal requirements (i.e., company law and relevant accounting standards).

If the directors are not maintaining adequate accounting records on a timely basis, they will not have a sufficient and up to date understanding of the financial position of the company.

Financial difficulties – preliminary definitions
As the Regulations are concerned with companies that are in financial difficulties, the Information Note considers what constitutes financial difficulties.

Insolvency
Section 818 of the Companies Act, 2014 (the “Act”) defines an “insolvent company” as “a company that is unable to pay its debts”.

Unable to pay its debts
Following on from the above, Section 509(3) of the Act provides that:

(3) For the purposes of this section, sections 224A, 271A and 520A, a company is unable to pay its debts if:

• it is unable to pay its debts as they fall due,
• the value of its assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities, or
• the circumstances set out in section 570(a), (b) or (c) are applicable to the company.

Section 570
Section 570 of the 2014 Act provides that a company shall be deemed to be unable to pay its debts

a) if:

• a creditor who is owed more than €50,000 has served a demand for payment (in writing) on the company, and
• the company has, for 21 days after the service of that demand, failed to pay the amount owed (or secure or compound for it to the reasonable satisfaction of the creditor), or

b) if:

• two or more creditors who are owed, in aggregate, more than €50,000 have served a demand for payment (in writing) on the company, and
• the company has, for 21 days after the service of that demand, failed to pay the amount owed (or secure or compound for it to the reasonable satisfaction of each of the creditors), or

c) any judgement or order of any court in favour of a creditor is returned unsatisfied in whole or in part, or

d) if it is proved to the satisfaction of a court that the company is unable to pay its debts

[1] Whereas section 570(a) specifies a figure of €10,000, that amount has been increased to €50,000 until 31 December 2023 by virtue of S.I. No. 648 /2022 -Companies Act 2014 (Section 12A(1)) (Covid-19) (No. 2) Order 2022

[1] Whereas section 570(b) specifies a figure of €20,000, that amount has been increased to €50,000 until 31 December 2023 by virtue of S.I. No. 648/2022 -Companies Act 2014 (Section 12A(1)) (Covid-19) (No. 2) Order 2022

Statutory directors’ duties
The Regulations insert a new section 224A into Chapter 2 of Part 2 of the 2014 Act. Section 224A(1) set out that:

“A director of a company who believes, or has reasonable cause to believe, that the company is, or is likely to be, unable to pay its debts, within the meaning of section 509(3), shall have regard to:

• the interests of the creditors,
• the need to take steps to avoid insolvency, and
• the need to avoid deliberate or grossly negligent conduct that threatens the viability of the business of the company”

This new section of the Act gives a legislative grounding to the pre-existing principal (as set down by case law) that the duty of care of directors moves from the interests of shareholders to the interests of creditors once they are aware that the company is insolvent or is likely to be become insolvent. Further details on this is set out in our previous article on the matter here.

Insolvency indicators
In order to ensure directors are aware, on an ongoing basis, of the company’s financial position the Information Note set out that directors should:

• have adequate accounting records
• regular management accounts
• budgets and
• cashflow forecasts.

In addition the Information Note also sets out a (non-exhaustive) list of indicators to assist company directors to identify at an early stage whether a situation might be developing in which the company would be unable to pay its debts. The list of indicators is set out in this appendix (pdf).

Restructuring
The earlier that a company can detect its financial difficulties and take appropriate action in response, the higher the probability of avoiding an impending insolvency or, in the case of a business the viability of which is permanently impaired, the more orderly and efficient the liquidation process is likely to be. Company restructuring involves a reorganisation of a company’s finances and/or business in order to enable the company to continue trading.

Restructuring options
There are a number of restructuring options available to viable companies that may be experiencing financial difficulties:

Examinership
Please find further details on Examinership here.

SCARP
Please find further details on SCARP here.

Informal restructuring arrangements
Private restructuring arrangements are sometimes negotiated between a debtor and some, or all, of its creditors. These flexible and informal restructurings are not a matter of public record.

Schemes of Arrangement
Under Chapter 1 of Part 9 of the Act it may be possible for a company to enter a scheme of arrangement with its creditors. This allows a company to reach an arrangement with its members or creditors or any class of them. Schemes of Arrangement are “commonly used for solvent restructurings and takeovers, and are being deployed with increased regularity for large-scale debt restructurings”.

Seek professional advice
The information Note recommends that directors of companies to whom are insolvent or is likely to become insolvent should carefully consider seeking professional advice at the earliest appropriate opportunity.

A professional advisor will be able to independently assess the business and either assist in turning the business around or advise on winding up of the company in an orderly manner. Seeking the help of a qualified advisor can also protect against any restrictions or liabilities a director might otherwise face. It is important for directors to maintain a record of any advice to demonstrate that the appropriate steps were taken when facing potential insolvency.

If you wish to find out more about any aspect of the above or wish to seek professional advice about restructuring or winding up a business, please do not hesitate to contact our restructuring and insolvency team for a confidential consultation.